Corporate Debt To EBITDA Hits All Time High

In its latest Global Stability Financial Report, the IMF issued a stark warning, bringing attention to the troubling and seemingly unstoppable growth in global corporate debt and the threat that could be unleashed by a sharp move higher in rates, one which the IMF estimates could result in as many as 22% of total corporations - amounting to almost $4 trillion in assets - being unable to cover their interest payments, leading to an avalanche of defaults. Furthermore, as the IMF highlighted, leverage had reached, and surpassed, historical levels which in the past translated into economic recessions.

The report prompted some to challenge the IMF report's assumptions, and to point out that leverage was in fact far more modest than during previous cycles.

To resolve this particular debate, Morgan Stanley has conveniently issued a report which looks at corporate debt from several different angles, and which reaches a uniform conclusion: debt, whether total or net, relative to either EBITDA, Cash From Operations or Free Cash Flow, is at or near all time highs highest it's been.

Here are the summary findings:

Most ways we slice the data, corporate leverage is elevated, in many cases at or near prior cycle peaks – IG gross leverage trends using medians, simple averages, weighted averages, a constant universe of companies, and aggregating total debt and EBITDA all tell a similar story. In high yield, leverage is also elevated along most of these measures.

Net leverage is less extreme than gross, but still near prior cycle peaks on most measures. IG net leverage using a weighted average looks the most benign relative to history, though we note that the weighted average is heavily skewed by a small number of very large names with negative net debt.

Visually, first we look at total non-financial leverage in the form of corporate debt and corporate bonds as a % of GDP. Both are at or near all time highs.

Next, MS looks at how total IG leverage is changing for a consistent universe of companies over time (constant universe) both using median leverage, and dividing total debt for the full universe by total EBITDA each quarter (aggregated);

When using the aggregated data, both gross and net leverage are at or near record leverage levels, well above prior cycle peaks.

MS then notes that some argue that leverage looks healthier focusing on cashflow vs EBITDA. It finds total debt/LTM cash from operations (CFO) actually looks worse.

More IG charts looking at total debt...

And net debt.

Digging into the data, some further component details:

Finally, away from IG, here is HY. Same picture, first on a total debt basis...

These CEOs act absolutely rational from their personal point of view. Risk-reward is set up in a way that makes them behave like that. Human beings will always do everything when they get rewarded for it.That's how incentives work. The FED has put up incentives to encourage ever more borrowing and spending. They openly state it. That's what this "monetary easing" is all about. It's a stretch of sorts to deny the FED's responsibility for a result that they have done everything for to happen.

You could blame fluoride. Harvard verified 40+ international studies showing short term exposure is correlated with a 7-8 pt drop in IQ. Executives running things now have probably had fluoride every day of their life.

There's a great documentary about this called Fluoride Poison on Tap (2015).

Seth Klarman's book said it was a metric created when other valuation methods showed absurdly high prices. This happens all the time. Tech companies were valued by mouse clicks and eyeballs because even things like EBITDA couldn't make them look good.

EBITDA can also be used as an indicator of immediate credit risk because interest is the first thing paid. Amortization is an imaginary cost, and depreciation expenses do not always require spending in the current year, but interest must be paid right now. If your EBITDA barely covers interest, you know the company is completely fucked.